TAX-FREE LATTE The U.S. Coffee Giant Has Sung The Starbucks Slips The .

TAX-FREE LATTEThe U.S. coffee giant has sung thepraises of its British business foryears, but reported big lossesStarbucksslips the UKtax hookBy TOM BERGINREUTERS/Andrew WinningLONDON, OCTOBER 15, 2012SPECIAL REPORT 1

TAX-FREE LATTE Starbucks slips the UK tax hookStarbucks’ coffee menu famously bafStarbucks’ tax reduction techniquestechniquesfles some people. In Britain, it’s theiraccounts that are confusing. Starbuckshas beenRoyaltyfees telling investors the businesswasmillionprofitable, even as it consistently 23.3reported losses.This apparent contradiction arises fromtax avoidance, and sheds light on perfectlylegal tactics used by multinationals the worldover. Starbucks stands out because it has toldinvestors one thing and the taxman another.The Seattle-based group, with a marketcapitalisation of 40 billion, is the secondlargest restaurant or cafe chain globally after McDonald’s. Accounts filed by its UKsubsidiary show that since it opened in theUK in 1998 the company has racked upover 3 billion pounds ( 4.8 billion) in coffee sales, and opened 735 outlets but paidonly 8.6 million pounds in income taxes,largely due because the taxman disallowedsome deductions.Over the past three years, Starbucks hasreported no profit, and paid no income tax,profitable on sales of 1.2 billion pounds in the UK.ss.McDonald’s, by comparison, had a taxbill of over 80 million pounds on 3.6 billion pounds of UK sales. Kentucky FriedChicken, part of Yum Brands Inc., the no.3 global restaurant or cafe chain by marketcapitalisation, incurred taxes of 36 millionpounds on 1.1 billion pounds in UK sales,according to the accounts of their UK units.Yet transcripts of investor and analystcalls over 12 years show Starbucks officialsregularly talked about the UK business as“profitable”, said they were very pleased withit, or even cited it as an example to follow foroperations back home in the United States.Troy Alstead, Starbucks’ Chief FinancialOfficer and one of the company officialsquoted in the transcripts of calls Reutersreviewed, defended his past comments, saying the company strictly follows international accounting rules and pays the appropriate level of tax in all the countries whereit operates. A spokeswoman said by emailthat: “We seek to be good taxpayers and toA CUPFUL OFLOSSESSTARBUCKS’ UKLOSSES, BY YEAR1998- 7.48 million1999-2007- 86.63 millionTOTAL 239.7 millionloss over 14 years2008- 26.3 million2009- 52.2 million2010- 34.24 million2011- 32.85 millionIn 2007, Starbucks’ UK unit’s accounts showed its tenth consecutive annual loss.Its Chief Financial Officer said the unit had margins of almost 15 percent that year –equivalent to a profit of almost 50 million.They are trying to playthe taxman, game him.It is disgraceful.Michael MeacherLabour MP and tax campaignerpay our fair share of taxes . We don’t writethis tax code; we are obligated to complywith it. And we do.”When presented with Reuters’ findings,Michael Meacher, a member of parliamentfor the Labour Party who is campaigningagainst tax avoidance, said Starbucks’ practice “is certainly profoundly against the interests of the countries where they operateand is extremely unfair . they are trying toplay the taxman, game him. It is disgraceful.”There is no suggestion Starbucks hasbroken any laws. Indeed, the group’s overall tax rate - including deferred taxes whichmay or may not be paid in the future - was31 percent last year, much higher than the18.5 percent average rate that campaigngroup Citizens for Tax Justice says largeU.S. corporations paid in recent years.But on overseas income, Starbucks paidan average tax rate of 13 percent, one of thelowest in the consumer goods sector.The UK tax authorities and the U.S. Internal Revenue Service (IRS) said confidentiality rules prevented them from commenting.A LOSSMAKER WITH FAT MARGINSYou could think of Starbucks’ differing versions of its experience in the UK as twodifferent coffees. To its investors, it sells anespresso – strong and vibrant. The UK taxSPECIAL REPORT 2

TAX-FREE LATTE Starbucks slips the UK tax hookman gets a watered-down Americano.The contradiction between the twostories becomes evident from scrutiny ofits group reports and the transcripts of 46conference calls with investors and analysts.Like most big corporations, Starbucks’group earnings statements do not breakdown its profits and tax payments by country, although on calls it occasionally sharesdetails about larger markets such as theUK. But companies operating in the UKare obliged to lodge accounts at the company register, Companies House, to give apicture of the unit’s financial performance.In the 2007 financial year to end-September, Starbucks’ UK unit’s accountsshowed its tenth consecutive annual loss.Yet that November, Chief Operating OfficerMartin Coles told analysts on the fourthquarter earnings call that the UK unit’sprofits were funding Starbucks’ expansion inother overseas markets. Then-Chief Financial Officer Peter Bocian said the unit hadenjoyed operating profit margins of almost15 percent that year – equivalent to a profitof almost 50 million pounds.For 2008, Starbucks filed a 26 millionpounds loss in the UK. Yet CEO Schultztold an analysts’ call that the UK businesshad been so successful he planned to takethe lessons he had learnt there and applythem to the company’s largest market – theUnited States. He also promoted Cliff Burrows, former head of the UK and Europe,to head the U.S. business.Schultz said he looked forward to Burrows“now applying that same drive and businessacumen to leading our U.S. business.”In 2009, accounts filed in Londonclaimed a record loss of 52 million poundsfor the financial year to Sept. 27, whileCFO Alstead told investors on a call thatthe UK unit was “profitable.”For 2010, the UK unit reported a 34million pounds loss, and Starbucks told investors that sales continued to grow.Starbucks UK unit’s accounts for theyear to September 2011 showed a 33 mil-Starbucks’ tax reduction techniquesANATOMYOF A 52MLN LOSSRoyalty fees 23.3 millionUnclear –transfer pricingmay be involved 22.6 millionInterest charges 6.3 millionIn 2009, Starbucks UK told investors it was profitablebut reported a record 52 million loss.What caused that?lion pounds loss. Yet John Culver, Presidentof Starbucks’ International division, toldanalysts on a call earlier that year that “weare very pleased with the performance inthe UK.”When Reuters asked Starbucks’ CFO Alstead which version was accurate – Starbucks’15%The profit margin Starbucks’ CFOtold investors the UK had madein 2007. That year it reported itsninth annual lossSource: Starbucksaccounts for the UK taxman, or its commentsto investors, he said: “The UK is very troubled,unfortunately. Historically it has performed alittle bit better than it does now.”He did not explain why the UK businesswas so disappointing, but said Starbuckswas “taking very aggressive actions” to improve its performance, including changingits cost structure.Meacher, the politician, said Starbucks’experience reflects broader problems in theUK system, which allows companies topay less tax than they morally should. Taxcampaigners say that failure is partly policy:successive governments have urged the taxauthority to take a pro-business stance. TheUK is one of the few rich countries notto have general anti-avoidance legislation,which the government is preparing now.SPECIAL REPORT 3

esllionillionionononons.ar –TAX-FREE LATTE Starbucks slips the UK tax hookPresented with the contradiction between Starbucks’ UK accounts and itscomments to investors, Starbucks’ CFOAlstead identified two factors at play, bothrelated to payments between companieswithin the group.The first is royalties on intellectual property. Starbucks, like other consumer goodsbusinesses, has taken a leaf out of the bookof tech companies such as Google and Microsoft. Such firms were identified by Senator Carl Levin, chairman of the U.S. SenatePermanent Subcommittee on Investigations, in a September hearing on how U.S.companies shield billions from tax authorities. He said they were engaged in “gimmickry” by housing intellectual propertyunits in tax havens, and then charging theirsubsidiaries fat royalties for using it.Like those tech firms, Starbucks makesits UK unit and other overseas operationspay a royalty fee - at Starbucks, of six percent of total sales - for the use of its ‘intellectual property’ such as its brand andbusiness processes. These payments reducetaxable income in the UK.McDonald’s also charges its UK subsidiary a royalty for ‘intellectual property’,although at a lower rate of 4-5 percent.The fees from Starbucks’ Europeanunits are paid to Amsterdam-based Starbucks Coffee EMEA BV, described by thecompany as its European headquarters, although Michelle Gass, the firm’s presidentin Europe, is actually based in London.It’s unclear where the money paid to Starbucks Coffee EMEA BV ends up, or whattax is paid on it. The firm had revenues of 73million euros in 2011 but declared a profit ofonly 507,000 euros. When asked how it burntup all its revenue, Alstead pointed to staffcosts and rent. The HQ has 97 employees.Alstead said some of the unit’s revenuewas also paid to other Starbucks units, including one in Switzerland. He declinedto say if fees paid for the use of the brand,which originated in the United States, aresent back to be taxed.Starbucks’ tax reduction techniquesINTER-COMPANY LOANRather than invest directlyin its European businesses,Starbucks lends to them.In the UK, its outlets paymore interest than somecompetitors 2,657 942McDonald’sinterest paid per outletStarbucksinterest paid per outletStarbucks’ UK unit pays roughly 2 millionin interest that is tax deductible a year, lowering its tax bill.For McDonald’s UK units, that bill is around 1 million.Professor Michael McIntyre at theWayne State University Law School saidit was rare for such fees to be repatriated tothe United States, where corporate profitsare taxed at up to 39 percent. In contrast inSwitzerland, lawyers say, earnings from royalties can be taxed at rates as low as 2 percent.Starbucks declined to comment whenasked if it used offshore jurisdictions inthis way.Arm’s LENGTHThe UK tax authority, Her Majesty’s Revenue & Customs (HMRC), allows companies to deduct intellectual property feesif firms can show the charges were madeat “arm’s length” – that is, if companies canshow they would have agreed on the termseven if they were not connected.One way to prove this is to show thata licence for which a royalty is paid is keyto the subsidiary’s profitability, said StellaAmiss, international tax partner with accountancy firm PwC. After all, if you arepaying for an asset that never generates aprofit, you are probably paying too much.“You would need to show a track record ofprofitability,” she said.Starbucks says it abides by the ‘arm’slength’ principle, even if the company hasnot been profitable in the UK.Accounts for McDonald’s UK unitshow it also pays trademark fees to associated companies, but these have generatedprofit. A spokeswoman for KFC said itsUK unit did not pay such fees.Accounting firm Deloitte, which auditsboth Starbucks’ group accounts and thoseSPECIAL REPORT 4